KBW Sees Silver Lining for Bank Stocks in Low Interest Rates - Barron's

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Low interest rates have been the scourge of bank stocks, but a recent analysis by the team at Keefe, Bruyette & Woods suggests that low rates may not be all bad.

Implied in the low rates is improved credit quality, Frederick Cannon, global director of research at KBW, wrote in a recent note.

While the immediate negative impact of low rates is that it constrains the banks’ net interest income, it also forces banks to become more selective about who they lend to, meaning that they are less likely to face credit losses down the line. Higher interest rates are great if a bank can collect them, but are of little help if loans go bad.

“The cost of collecting on poor credits is high and generally more than offsets fees generated from delinquencies,” Cannon wrote.

Of course this dynamic has not yet played out in U.S. bank stocks’ performance. The KBW Bank Index (ticker: BKX) has pared some losses since its March lows but is still down 32% this year despite the broader market flirting with all-time highs. Bank investors have been worried about low interest rates -- which are almost certain to be in effect for some time -- as well as looming loan losses. While much of the economy is operating at reduced capacity and millions remain unemployed, investors and analysts have been nervous about the sector’s credit exposure.

But KBW looked to second-quarter financial results and further projections and saw signs of the positive impact of lower rates. Expected credit costs for 2021 fell by $11 billion for banks in KBW’s coverage universe after the banks reported results while the drop in expected net interest income fell by $5 billion.

“The greater drop in provision expense than net interest income suggests a positive impact from the decline in interest rates in the quarter from the decline in bond yields that occurred,” Cannon wrote.

Of course, investors are still skittish on bank stocks. Berkshire Hathaway (BRK.B) notably trimmed many of its bank holdings during the second quarter.

The KBW Bank Index was off by 1.8% in Monday’s trading, while the S&P 500 gained 0.3%.

Write to Carleton English at carleton.english@dowjones.com

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KBW Sees Silver Lining for Bank Stocks in Low Interest Rates - Barron's
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